RDP 2016-10: The Effect of Consumer Sentiment on Consumption 7. Conclusion

We have sought to identify whether changes in economic beliefs reflected in consumer sentiment indices have a causal effect on consumption. To do this, we have used variation in sentiment around changes of government that is plausibly unrelated to changes in current fundamental drivers of consumption. In particular, we have taken advantage of the fact that consumers are substantially more optimistic about economic conditions when the party they support is in government. The difference in sentiment between supporters of the two parties is large and changes occur immediately following an election at which there is a change of government.

To see if the beliefs captured in sentiment affect consumption, we match an individual consumer's expectations of future economic conditions from the consumer sentiment survey to their spending intentions. We find that consumers that have a more positive economic outlook report more positive spending intentions. We validate these results using actual postcode-level consumption data. In particular, following an election with a change of government, motor vehicle purchases increase by relatively more in postcodes with a greater share of voters for the winning party.

We believe that our results have important implications for policymakers and researchers for two reasons. First, we find that spending intentions elicited in sentiment surveys are a good proxy for actual consumption. Since individual-level consumption data is difficult to obtain, our results provide support for researchers using spending intentions to study consumption responses. Second, we find that consumer sentiment has a casual effect on consumption. Given our extensive use of controls and the large movement in sentiment we observe at changes of government, we believe that the variation in sentiment we identify represents pure sentiment shocks rather than unbiased expectations about changes in future incomes. Therefore, consumer sentiment can contain important information not captured by other macroeconomic indicators. From a policymaking perspective, this suggests that divergences between consumer sentiment and the level of economic activity implied by macroeconomic data can contain important information about future consumption.

The cross-sectional variation in sentiment around changes of government that we have used is not visible in aggregate sentiment data because the different views held by supporters of each of the major political parties largely cancels out. Thus, our results do not imply that changes of government have any noticeable effect on aggregate consumption. Because much of the variation in aggregate-level sentiment reflects variation in fundamental drivers of consumption that are common to macroeconomic time series and sentiment, separating meaningful variation in aggregate sentiment from measurement error is difficult. We leave to further work the challenge of identifying specific episodes similar to that we have studied at the individual level in aggregate data.